October 19, 2005
Wednesday AM

WASHINGTON - It was one thing for President Bush to run for re-election last year by campaigning against the "mess" of an income tax code and for a "simpler, fairer" system.

It's another now that his blue-ribbon panel is poised to recommend two reform choices Nov. 1 that streamline taxes by eliminating most tax breaks and replacing them with new benefits.

Former Sen. Connie Mack, R-Fla., the panel chairman, predicts any successful reform will build on a simplified version of the current income tax.

But as former senator and panel co-chair John Breaux, D-La., notes, tax reform is, well, just plain taxing when "everything you give with one hand and take away with another makes for difficult politics."

The Treasury Department will cull the options for Bush to choose which, if any, to send early next year to Congress, where it won't be an easy sell because the advisory panel gores sacred cows and oxen alike. Options likely to be in the panel's final report, outlined at its last hearing Tuesday, are:

SIMPLIFIED INCOME TAX: Four tax brackets would replace the current six, with 75 percent of filers in the lowest 15 percent tax bracket and 75 percent of capital gains on profits from U.S. company stocks tax-free. Under this plan:

- The deduction for state and local income, sales and property taxes would die.

- The Alternative Minimum Tax projected to hit one third of taxpayers by 2010 would die, too.

- The current $1-million home mortgage and $100,000 home equity deductions would be replaced with a mortgage credit for the principal residence, whether the homeowner itemizes or not. The credit would equal the average Federal Housing Administration insured loan by region, which ranges from $172,000 to almost $313,000.

- The $500,000-a-couple tax break on profits from home sales would expand to $600,000 and be adjusted for inflation, but any capital gains on a home sale above that limit would be taxed as ordinary income.

- Health insurance through work would be tax-free up to $11,500 for families, $5,000 for individuals. Taxpayers without employer-provided coverage would get an equivalent tax break for individual policies they buy. Other fringe benefits would be taxed as income.

- A single-family tax credit would replace the plethora of personal exemptions and family tax breaks, and charitable contributions above 1 percent of income could be deducted even by non-itemizers.

- Savings accounts for retirement, health and education would be replaced with three savings accounts, all funded with after-tax income that grow tax-free and are tax-free at withdrawal. One would be for workplace retirement savings, the second for personal retirement savings and the third for family savings.

Former IRS Commissioner Charles Rossotti, a reform panel member, said that "everybody from top to bottom would pay about the same income tax" but that everybody's 1040 tax form would shrink from 75 to 32 lines and the 52 worksheets needed to prepare taxes would be cut to 10.

"PROGRESSIVE CONSUMPTION" TAX: The six tax brackets would shrink to three - 15, 25 and 35 percent - for wages and salary, but investment income would be tax-free. Alternately, capital gains, dividends and interest could be taxed a flat 15 percent rate to ensure that high-income people who live off investments pay at least a little. Under this plan:

- A streamlined business tax of 35 percent of cash flow after costs would compensate for ending or lowering individual taxes on dividends and capital gains.

- The Alternative Minimum Tax would be eliminated, and a family tax credit similar to the streamlined income tax's provision would adjust for family size.

- There would be a similar home-mortgage credit and charity deduction for contributions above 1 percent of income. Health-care benefits through work would be tax-free only up to $8,400 a family, or $4,000 for singles.

Panelist Liz Ann Sonders, chief investment strategist for Charles Schwab, said the proposal should unleash investment and growth to compensate for favorite tax breaks.

But panelist Beth Garrett of the University of Southern California law school worried that the system would hit hardest at low- and middle-income wage-earners who consume most of their income and compound the "regressive" character of Bush tax cuts that already favor the richest 20 percent.

HYBRID INCOME AND VAT - The most radical proposal would have wed a simplified income tax with a value-added tax, or VAT - a sales tax that's paid at every stage of production and ultimately by the consumer. But the reform panel rejected the option. Outside tax analyst Chris Edwards of the Cato Institute praised the decision on grounds VAT taxes in Europe have fueled government spending.

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